What is Price-to-Earnings (P/E) Ratio:
The ratio used to value a firm that compares its current share price to its earnings per share (EPS) is called the price-to-earnings ratio. The price multiple or earnings multiple are other names for the price-to-earnings ratio.
Investors and analysts use price-to-earnings ratios (P/E ratios) to compare a company's shares to others in the same industry and ascertain the relative worth of those shares. Additionally, a company's past performance may be compared, as can the aggregate markets' performance over time or against one another.
KEY KNOWLEDGE
Price-to-Earnings Formula and it's Calculation:
P/E Ratio = (Current Market Price of a Share / Earnings per Share)
Cost in Relation to Earnings One of the indicators that analysts and investors use the most frequently worldwide is the ratio. It is the sum of money an investor is ready to put up for a single share of a business in exchange for ₹ 1 of its earnings. For example, investors are prepared to pay ₹ 20 for a business's stocks for ₹ 1 of its current profits if the company has a P/E ratio of 20.
Therefore, a high P/E ratio indicates that a firm is either overpriced or is headed for growth. Another way to interpret a high price-to-earnings ratio would be to say that analysts and investors are speculating that the firm will see higher revenue in the future, which has caused the stock price to soar.
Types of P/E Ratio:
It is computed by dividing the projected earnings of a firm based on its future earnings guidance by the price of a single unit of its shares. This ratio is also known as an estimated P/E ratio as it is predicated on a company's potential future profits.
Investors evaluate a company's projected growth rate and future performance using the forward price to earnings ratio.
Trailing P/E Ratio is the most commonly used metrics by investors; wherein past earnings of a company over a period is considered. It provides a more accurate and objective view of a company’s performance.
EXAMPLE
Reliance Industry Limited:
Current Market Price of a Share / Earnings per Share = ₹2394/₹101 = 23.70
What is the good P/E Ratio?
In the end, it's difficult to pinpoint an ideal P/E ratio. However, many value investors believe that lower P/E ratio is preferable overall. As previously mentioned, these ratios are frequently utilized in a comparison manner, thus what is good or poor often depends on what it is being compared against.
To give you some sense of what average for the market is, though, many value investors would refer to 20 to 25 as the average P/E ratio range. And again, like golf, the ,b>lower the P/E ratio a company has, the better an investment the metric is saying it is.
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Frequently Asked Questions
20 to 25 as the average P/E ratio range.
Once a company becomes more mature, it will grow more slowly and the P/E tends to decline.
The P/E ratio also changes as companies report earnings, typically on a quarterly basis
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